My thoughts on Flipkart...

I should begin by clarifying that I am no expert on E-Commerce. I do not hate Flipkart, although as a once loyal customer, I hate to see what is happening to the company. I do not know any Flipkart employee personally, and these are my thoughts as an external observer.

I have worked in the consulting space for nearly 10 years, with startups and entrepreneurs for the most part. As I understand it, a successful startup finds a niche area and exploits that niche to achieve a commanding position before expanding into other areas and pursuing rapid growth.

Flipkart was founded with books as their niche. Why did they choose books? Maybe they were just copying Amazon, but books as a category made perfect sense. Books are a high margin product and fairly standardized, unlike, say, clothing, where size and fitting can cause much grief after the product is purchased.

Let's rewind to 2007, an era prior to smartphones and tablets. An era prior to 3G. An era before Cash on Delivery. An era before same day delivery. The smartest phone at the time was a Nokia, and anyone found accessing their e-mail on a phone was considered super advanced.

Hardly anyone bought stuff online, (Indians have a trust issue: paise leke nahi bheja toh?) and those who did, bought from Amazon.com. The import of these products took forever, and the currency exchange was opaque so, one had no idea how much they would end up paying. Personally, I used to buy books from Amazon only when I could not manage to source it despite several requests at local bookshops.

Flipkart arrived in this market as perhaps one of the first online e-commerce portals in India. To overcome trust issues, they started offering books at deep discounts, sometimes even 40%. For those who understand the book business, books have quite a high margin, in some cases almost 60% if the seller is willing to purchase them in bulk. It was possible to earn a profit on a per transaction basis even after offering steep discounts. The discount incentivized people to take the risk, and sales started rolling in.

Flipkart was the first company to introduce Cash on Delivery, and all the associated pains for people handling operations. (Try speaking to an e-commerce player about the number of returns they see on COD orders.) Joy to the consumer, though: there was no reason to fear non-delivery post payment anymore. Add discounts to the mix, and orders began to pick up. Even your dad’s friend was suddenly recommending that you buy books on Flipkart.

Delivery was free above a very low threshold, so if one bought a couple of books, it would be delivered for free with Cash on Delivery. Indians were not used to this kind of customer service. They loved it and lapped it up.

Delivery Moat

The company would have known fully well, based on what was happening in the US, that it would be quite easy for others to set up a website like Flipkart and begin sourcing products. They saw the delivery side of their business as their biggest competitive advantage. They invested heavily to build e-kart, the delivery end of the business, to ensure that they had the most comprehensive coverage of India. This was to serve as their competitive advantage.

Even if Amazon was to enter the market, they would not be able to cover the country as comprehensively as Flipkart, potentially making the latter a great acquisition or a formidable competitor.

Enter Investors

Investors play to make capital gains. They do not seek to take a share of the profit home. They want to invest at a lower valuation and exit at a higher valuation. For a company that is yet to make profits, they use proxies such as Gross Merchandise Value or GMV (kitna maal bika?) or the number of users transacting on the platform. The assumption is that these users will become profitable in the future due to scale and market leadership.

The investor made the investment at a particular valuation. In order to be able to claim a higher valuation in the next round, this proxy had to show a maniacal growth rate. Even more importantly, the investor needed to be able to project a ridiculously high number for the future.

Consider an example. If a company sells an average of $10 worth of books to 1 million users, we have a GMV of $10 million. If investors enter the company at this stage, they would want to be able to show very high growth rate, and also claim a projected GMV of $1 billion, to be able to get a higher valuation next round.

It is highly unlikely that the company would start selling to 200 million users when smartphone penetration in the country was in low single digit percentages; nor could it sell $1000 worth of books to each of the users. Realistically, the user base of 1 million would probably grow to 10 million users over 3 years, but sales had to grow from $10 to $100. Clearly, this was not possible selling books alone.

Enter multiple categories

The trouble with this strategy was, although it allowed the company to easily increase the gross merchandise value to $100, it meant entering product categories like electronics. In stark contrast to books, this category offers less than 10% in margins.

Chasing a niche, Flipkart had built a customer base that was essentially discount seekers, and they were not going to be able to sell products at full retail prices. Trust issues.

Unit Economics – possibly the most important, and paradoxically the most ignored part of the business. If a product is sold above price, with wafer thin margins, there will come a point, at some scale, where profitability would be possible. But when a product with 8% margin is sold at a 30% discount, an increase in volumes will raise losses, not profitability (a story that is repeating itself with food delivery startups). No bulk purchase or scale could ever make it possible to bring profitability at the transaction level. Entry into multiple categories accelerated sales and losses.

Flipkart is still trying to figure out how to come back from that point to a scenario with no discounts. As it stands, the company finds itself in a position where it loses more money each time it sells something. Unless further funding can be brought in at regular intervals, it seems unlikely that they would be able to withstand such losses much longer. Investors have begun to recognize this problem, and the money is drying up, slowly but surely. Flipkart raised INR450 crore in debt funding from HDFC Bank last month. Equity is increasingly difficult to raise.

Why are they here?

The issue begins with the investors, who like to play passing the parcel. Often, people wonder why an investor would put money into a venture that is unlikely to be profitable anytime soon. As discussed above, investors seek capital gains.

Investor 1 enters the businesses when the turnover is, say, 10 at a valuation of 100. The investor waits for the turnover to reach 30 so the company can raise a second round at a valuation of 500. Hopefully, Investor 1 would be able to cash out the principal that had been deployed and get into a no profit, no loss territory. Even if the cash out is not possible, notionally the value of the shares owned have gone up.

The idea is to keep this passing the parcel going with newer investors until the company can launch an IPO.

Since investors depend on proxies, there is a single-minded focus on increasing those; rather than focusing on profitability. Somebody at the end of the rainbow will figure that out. Right now, the valuation needs to shoot up.

The valuation kept rising as planned, but so did losses. In the mad dash to increase turnover, they completely lost sight of profitability.

I would like to add here. Flipkart was one of the first companies to be entering the space back in 2007, hope and exuberance pushed things forward quiet fast. Investors are a lot more cognisant of achieving profitability these days and hence startups are getting culled a lot sooner. Case in point - food delivery space.

Why did they not see this coming?

One often meets his destiny on the road he takes to avoid it ~ Master Oogway

Marketplace - In an attempt to keep Amazon out of the country, Flipkart kept lobbying the government against allowing international companies to enter multi-brand retailing. This worked well for a while, but the people at Amazon are nothing if not resourceful. They entered the country using the market-place model. In effect they would have no goods at their end, tie up with a bunch of vendors, manage the website and part of the delivery. The main drawback of this model is the company would have to loosen control of quality of service and perhaps handle more complaints and returns.

An eco-system for marketplaces began to develop. Suddenly, everybody was starting an e-commerce website using the same model.

Delivery Moat - As explained earlier, delivery was to be their competitive advantage. The development of the marketplace eco-system spurred the development of companies like Delhivery, which provide logistics support to e-commerce business. The inherent strength that Flipkart had built suddenly began to take lethal blows. As more and more companies jumped into the delivery business, the value of this piece kept falling.

Smartphones - All those years of marketing and drawing customers to the website and making the URL known also began to loose value as the smartphone started becoming the preferred means to reach high value customers. The smaller upstarts were developing their platforms to take advantage of mobile, while Flipkart had to adapt to mobile. In the initial days the experience on the Flipkart mobile app was quite bad.

How to survive?

Given the situation today, discounting is unlikely to end anytime soon in the Indian market. Amazon has a global business, and the ability to cross-subsidize, i.e. use profits from one market to cover the loses in another. Amazon also has a history of killing its competitor through price competition. There is no reason why they should refrain from doing so in India.

Paytm and Snapdeal have raised money from Alibaba, and they will be able to find more support in the future as well. The Indian e-commerce space will likely shape up as a war between Amazon and Alibaba (albeit using a proxy). While Snapdeal’s position and next steps are unclear, Paytm will almost certainly become a formidable business going forward. They will be able to use the robust profitability of their wallet to offset any losses that accrue from e-commerce (like Google offsets everything with search).

There is room for niche players and smaller e-commerce brands. It is going to be extremely difficult for Flipkart to be the Amazon of India. The way forward would be to kill discounts. This would mean a loss of turnover, and layoffs. But this will enable the company to reduce losses, inch towards profitability and, ultimately, survive.

I am doubtful that the investors would allow this to happen because it would mean taking a hit on the valuation. They would much rather try to sell parts of the business to interested suitors at a much higher valuation than take a hit on the overall valuation and allow the company to function as a whole.

Post Scriptum: Maybe...

It is easy, in hindsight, to say certain things could have been done better. But situations and circumstances determine a company’s responses. Given the place Flipkart was in, they had no reason to believe that things would not play out as they envisaged it.

But several factors changed much quicker than anyone could anticipate. You could not check Facebook on your phone in India, 7 years ago. 3G was launched in India at the end of 2008, and became mainstream in 2010. When you consider the situation in terms of economic cycles, 7 years is a very short span of time. USA is still recovering from the bust of 2008. The evolution of technology, internet and business models conspired against Flipkart and delivered a body blow.

Any and every business is built on a set of assumptions; if and when those assumptions do not hold true, it becomes incredibly difficult to deliver upon the vision that one embarked on.

Some things that could have been done differently:

• Vertical Integration - Flipkart was right to focus heavily on the delivery part of their business. But if Flipkart had not been a vertically integrated model, where they owned every piece of the delivery, they could have rapidly expanded across South East Asia & Middle East and hedged the risks.

• Languages - If the plan was to focus on India, language is the greatest challenge. Only 20% of Indians know English. 1 billion people still do not know English. This could have been a formidable competitive advantage and an opportunity to create brand loyalty that would have been difficult for an international competitor to overcome. I am not sure if Flipkart supports Indian languages even today.